What Shrewd Investors Know About Disney’s Buyback

One of the advantages that comes with the turf of buying and holding a particular stock for a long period of time is that you hopefully become familiar with it in a way that someone taking a cursory look at the stock may not notice.

For instance, it is well known in the investor community that Disney typically spends four times as much money repurchasing stock as it does paying out dividends. This fact, coupled with the Disney Board’s decision to pay out the dividend annually, can partially explain why income investors looking for retirement income avoid the stock altogether. There aren’t a whole lot of people in the world who can look at a 1% yield and say, “Yeah, that’s something I can rely upon for retirement.”

Another reason why someone might get deterred from the stock is that, at first glance, the buyback appears to be ineffective: Disney had 2 billion shares outstanding in 1998, and now has 1.75 billion shares outstanding in 2014. For a company spending $4-$5 billion repurchasing stock each year, you’d like to see a share count declining faster than that.

If you are really paying attention to Disney closely, as someone might be if they have been holding the stock for years and years, then you would know what Disney is doing here: they are aggressively taking shares of its stock off the market and then using to make targeted acquisitions that increase total profits without adding to the number of stockholders entitled to the profits.

2007: New Horizon Interactive (creators of Club Penguin, now called Disney Online Studios Canada)

2009: Marvel Entertainment

2010: Playdom

2012: Lucasfilm

Of those 12 acquisitions, 2 have been sold (Miramax and the Anaheim Angels), and 1 saw some of its assets sold (Saban Entertainment). The rest are still part of The Walt Disney family.

The only data I currently have on hand are Disney’s financial statements since acquiring the Muppets (but not Sesame Street) in 2004. At the time, Disney’s profits were $2.2 billion. Now, due to all of these acquisitions, Disney’s profits have ballooned to an expected $7.5 billion by the end of 2014. Disney’s secret sauce is that they have able to increase profits 3-4x times in a decade but the share count actually declined somewhat over that time due to the buyback.

That’s something that can be easy to miss if you’re not paying close attention—at most companies, we’re trained to associate stock buybacks with lower share counts which give you a higher claim on the profits for the shares that you own. Disney’s strategy tweaks that principle a bit; the stock buyback allows Disney to gobble up other companies that add to overall profits without having to expand the share count commensurately. In other words, when Disney does something like buy LucasFilm, they use repurchased shares to do so—those $300 million in annual profits continue to be divided in 1.8 billion ways instead of having to divide them in 1.9 billion ways if the share count actually got diluted.

I understand why income investors avoid Disney, and it’s hard to call declining to purchase a particular stock a mistake (if you buy Exxon, Nestle, or Berkshire Hathaway instead of Disney, and hold for 25+ years, your life is going to be fine), but I think Disney has a lot more appeal than its typical lack of love from income investors would suggest. The assets are high-quality, it can add meaningful diversification to a portfolio because there are no other media companies I can think of that fall into the “buy and hold for the rest of your life” category, and the dividend growth is spectacular if you stick around for a while.

Instead of thinking from the perspective of the current 1% yield, think of this: Ten years ago, Disney was paying out 19% of its profits as dividends (very similar to the 22% figure now). At the time, Disney was trading at $20 per share while paying out a $0.21 annual dividend. That 1% yield is very similar to what we see today. Yet, Disney is now paying out a dividend in the amount of $0.86 per share, giving you a 4.3% dividend yield on the amount of money you set aside ten years ago. As compensation for waiting ten years to get a 4% yield from your invested capital, you also got a stock price that more than quadrupled, turning $25k into $100k without factoring in the dividends over the decade. With Disney, most of your wealth will be on paper due to its longstanding buybacks over dividends preference, but you can do all right from a yield-on-cost perspective if you stick around for the while, and you could convert that to a whole lot of income if you stick around holding the stock for a while.

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